What happens next?26th January 2014


The apparent suddenness and rapidity of the UK recovery has greatly encouraged those who rely upon sound-bites to sustain their place in society, and has even thrown Mark Carney’s much-vaunted interest rate guidance off course.  With the wind apparently set fair even those market bears seem to have joined the consensus in their predictions for the year. But what do the next few years really have in store?

Well last week I had the pleasure of dinner with a small gathering of out-of-the-box thinkers, ranging from fund-managers, a banker close to the 2007/08 crisis, a trans-continental property developer, those drawn from the world of arts, philosophy and small business. Our common bond was a real understanding of the monetary system, the ills and potentially explosive consequences that it creates. But how, practically, might that impact on us all down the road? Read on …

But before we get too deep, let me summarise some of the issues that we face in the UK alone:

  • The inflation rate is apparently benign … albeit consistently and heavily under-reported in official statistics.
  • Unemployment is reducing, employment is rising … although many are having to take part-time jobs, whilst employers struggle with real skill gaps to build genuine wealth-generating roles. After transport and childcare costs many benefit little from work other than the enjoyable company of their colleagues.
  • Deflation “risk” is starting to be discussed in polite circles … although those in power really do see lower prices as a great evil to be avoided because it hits their debt load.
  • Our major trading partner, the Eurozone, remains a morass of un-reconciled cultural and economic differences … the can has just been kicked down the road.
  • Youth unemployment is too high … and too many have left University mired in debt before they even start their productive lives, unable to find relevant roles in society, and unable to dream of a home of their own.
  • Banks continue to be heavily inter-connected, leveraged and over-exposed to government debt … whilst regulation protects them from exposure to the competitive free-market that would restore sound practice.
  • Corporate profit margins benefit from government spending and low labour costs … yet investment is too low.
  • Our economy continues it’s over-reliance upon consumer spending and state services … with little of GDP representing real value-added sustained wealth generation for now or the future.
  • Vast sums are drawn from productive society in taxation, to feed unproductive “ring-fenced” sections of the public sector … indeed even those that have not been ring-fenced have generally increased their spending, with education and healthcare unable to provide the necessary results.
  • The suppression of interest rates through QE has created great returns for some, increasing the gap between those with capital and those who must rely on taxed income … and distorting the time preference for money leading to malinvestment.
  • The country’s safety margin of energy generating capacity is rapidly diminishing … whilst the cost commitments on new green and nuclear capacity are rocketing, undermining our international competitiveness.
  • Our competitive devaluation of the last few years against other currencies is hailed as beneficial … but only succeeds in removing our wealth and imports inflation.

So whichever way you look at it, whether it be the impositions of debt, tax, energy costs, unemployment, inflation, education and uncertainty, the state has done much to diminish opportunity for the majority, whilst steadily increasing it’s grip upon us all. This is the big problem with our monetary systems … they enable the state and vested interests to get away with all this damage, whilst convincing too many that only more state is the answer!

Despite the so-called recovery, we are now left with just as much, and perhaps even more distortion that we faced at the “height of the crisis” a few years ago.

So what happened to capitalism?

As a proponent of the free-market, what difference would real capitalism have made? Well for a start, free-market capitalism optimizes the balance between employment, wages, education, consumer prices, asset prices, bank security, interest rates, healthcare and all other wants and needs, whilst enabling us to benefit from lower prices through international competitiveness, innovation and specialization. It matches demand and supply to maximize the fulfilment of wants. It uses a monetary system that cannot be fiddled and fudged. Through accurate price signals it is an automatic balancing mechanism that protects the many against the few, and offers strong motivation for betterment. Through the most effective allocation of investment and labour, demand and supply at all levels is optimized, enriching the living standards of wage earners for generation after generation.

One day, politicians and central bankers will be found-out to be the costly irrelevance that they are. Too many arbitrary decisions are taken by the powerful and remote who have no understanding of each individual’s needs, wants & priorities. In our monetary system price signals are distorted by inflation, and regulation empowers crony-capitalism. Nassim Taleb, that wonderfully radical free-thinker, in his latest book Antifragile, makes the case that our apparently robust institutions are continually fighting yesterday’s battles … and are therefore anything but robust … whereas we would benefit from anti-fragile organisation that grows stronger from adverse events.

Whilst we as a nation, both the state and individually, continue to spend more than we save and invest, our growth is not sustainable. How Government might be expected to positively assist us in this necessary process of saving and investing for our future is a laughable travesty.

To the extent that we do move forward, any excitement surrounding the potential of new energy, biotech, robotics, nanotech and communications could easily be wasted or regulated away by an over-involved state. We need to return to basics. But back to that dinner …

So what future possibilities did I glean at this dinner?

  • Far too few people are educated in or seek to understand money, so they are unable to query the monetary and political systems that enslave them … for those that are educated much economic teaching is riddled with inaccuracy.
  • Crisis equals opportunity. The politicians had a 6 month window to change things at the height of the crisis, but bottled it. Another crisis will come, because nothing has changed, and we must hope that enlightened thinking prevails … although the majority of the current political class are seemingly too cynical or naive or ignorant to do the right thing.
  • Whilst taking more and more people out of income taxation altogether sounds great, this means that even fewer have a stake in the society they vote for … such activity will only serve to break the system sooner rather than later.
  • Historically, debt monetization has a proven track record of bad endings as sufficient people loose faith in their paper currency. The trigger for that (at least for us in the UK) is likely to be an adverse external event … it’s just a matter of when.
  • Demographics will steadily increase the proportion of young who have no stake in the economy, burdened by debt, taxation and without assets … so should we still be awaiting that external event, a tipping point will occur where their anger will count for more than the votes of the retired.
  • Bank bail-ins are unlikely to happen in the UK, but to the extent to which they do, they will be focused politically on the banks seen as being used by the wealthy … in fact we would all be better off without bank deposit insurance … banks would then compete on their safety for the “return of  investment” rather than the “return on investment” and much of the enormous and inappropriate leverage would dissipate from the banking system.

But what do I think?

To understand the power of demographic change, consider that in the ‘90s retirees consisted of only 15% of the population, and there were more than 3 workers for every retiree. We will soon be closer to 2 workers for every retiree. How that translates into sustainable pensions for all is a mystery. Perhaps that will be the ultimate trigger for change.

There will be change. For the past few years we have seen unabated inflationary zeal and financial repression to maintain the status-quo. That has not created real wealth, nor will it. Yet until we have an “outlier” or “black swan” event the ability of the powers to sustain the unsustainable with moral hazard may well continue, but things must eventually unravel … demographics will see to it.

I personally believe that we will see default and bail-ins, just as we saw in Cyprus and through continued political financial repression … but deciding how we retrace from the failures of social democracy back to the benefits of unbridled capitalism will fall to an enlightened younger generation, for whom the benefits of capitalism are waiting.

In the meantime we are left with the 6Ds: Demographics, Deficits, Debts, Deleveraging, Deflation and Default. Life’s a gamble. But like any New Year, have a number of plans in place so you are prepared to react to all eventualities … when the dynamite goes off, wherever in the world that may be, it’ll pay to be prepared!

For international and domestic businesses that wonder where that leaves them with the risks and rewards they face … well, please do get in touch. And have a great year!